Question

Kauffman has bonds outstanding with a face value of $1,000 and 10 years left until maturity. They have an 11% annual coupon payment, and their current price is $1,175.

A. What is the yield to maturity?

B. What is the yield to call AND the yield to maturity if they are called in 5 years, 6 years, 7 years and 9 years? Prepare in excel for (a, b and d).

C. Which yield might investors expect to earn on the bonds? Why?

D. The bond's indenture that the call provision gives the firm the right to call the bonds at the end of each year beginning in year 5. In year 5, the bonds may be called at 109% of face value; but in each of the 4 years, the call percentage will decline by 1%. Thus, in year 6, they may be called at 108% of face value; in year 7 they may be called at 107% of face value; and so forth. If the yield curve is horizontal and interest rates remain at their current level, when is the latest that investors might expect the firm to call the bonds?

1. Explain with detailed explanation of the conclusion reached concerning whether or not to call the bond before maturity.

2. If your recommendation is to call the bond early, explain when to call the bond and rationale.

3. Discuss the advantages and disadvantages of using a long term loan instead of a bond.

Answer 1

1-	YTM	Using rate function in MS excel	rate(nper,pmt,pv,fv,type) = nper = 10 pmt = 110 pv= -1175 fv =1000 type = 0	RATE(10,110,-1175,1000,0)	8.35%
2-	YTC if called in Year 5	Using rate function in MS excel	rate(nper,pmt,pv,fv,type) = nper = 5 pmt = 110 pv= -1175 fv =1090 type = 0	RATE(5,110,-1175,1090,0)	8.13%
	YTC if called in Year 6	Using rate function in MS excel	rate(nper,pmt,pv,fv,type) = nper = 6 pmt = 110 pv= -1175 fv =1080 type = 0	RATE(6,110,-1175,1080,0)	8.27%
	YTC if called in Year 7	Using rate function in MS excel	rate(nper,pmt,pv,fv,type) = nper = 7 pmt = 110 pv= -1175 fv =1070 type = 0	RATE(7,110,-1175,1070,0)	8.37%
	YTC if called in Year 8	Using rate function in MS excel	rate(nper,pmt,pv,fv,type) = nper = 8 pmt = 110 pv= -1175 fv =1060 type = 0	RATE(8,110,-1175,1060,0)	8.46%
	YTC if called in Year 9	Using rate function in MS excel	rate(nper,pmt,pv,fv,type) = nper = 9 pmt = 110 pv= -1175 fv =1050 type = 0	RATE(9,110,-1175,1050,0)	8.53%
3-	Investor prefer to take YTC at call option at year 9 as it results in highest rate of return (YTC = 8.53%)
4-	Firm will call the bonds in the year 6th because at this point firm because This is the last year that the expected YTC will be less than the expected YTM. At this time, the firm still finds an advantage to calling the bonds, rather than seeing them to maturity
1-	company can call the bonds in the year 6 because at this point of time YTC is less than YTM so it is better for the company to call the bond because 7th year onward YTC start rising than the YTM so it is beneficial for the company to call the bond in year 6
2-	Firm will call the bonds in the year 6th because at this point firm because This is the last year that the expected YTC will be less than the expected YTM. At this time, the firm still finds an advantage to calling the bonds, rather than seeing them to maturity
3-	Long term loans are not subject to market interest rate risk which lead to change In the value of debt while bond prices are subject to change due to market interest rate risk. Bonds can be redeemed before maturity if market interest rate fluctuates by doing a YTM and YTC analysis while this is not possible in case of long term debt